What can be the main causes of deterioration of the financial situation of the company?

In 1933, US President Franklin D. Roosevelt pointedly noted that "confidence... thrives on honesty, on honour, on the sacredness of obligations, on faithful protection and on unselfish performance. Without them it cannot live". And over 80 years later these words still resonate with political, policy and business leaders as they grapple with increasingly fickle cycles of consumer and business confidence.

To be fair, global policymakers are currently confronting a perplexing set of factors in the aftermath of the financial crisis and major central banks' deployment of unconventional monetary policy via unprecedented asset purchase programs and negative interest rates. Arguably, the crisis of 2008-09 and its legacy continue to cast some doubt on the effectiveness and accountability of policymaking institutions in the major developed economies.

Confidence levels in the major developed economies have also been influenced by concerns about the socioeconomic consequences of the unrelenting pressure for ‘structural change’ in an increasingly competitive global economic system. At the household/consumer level, a key concern has been persistently high levels of unemployment faced in some regions and subdued income growth in developed economies, while for businesses, sluggish demand and highly competitive operating conditions continue to influence perceptions of resilience and confidence.

Consequently, as the global economy moves into the second half of 2016 it is important to understand the causes and consequences of shifts in consumer and business confidence and the possible implications for the business cycle and macroeconomic policy settings.

Confidence may be a case of shifting sands

With policymakers in the major economies working hard to restore and maintain confidence levels and shifts in sentiment indicators playing a key role in risk assessments of investors, it is worthwhile to consider the various influences on this qualitative economic measure.

Our analysis of the various indicators of consumer and business confidence that are regularly published highlight several common factors that have the potential to cause marked shifts in sentiment; including:

Changes in interest rates and/or exchange rates, particularly if they are rapid, large and unexpected

Swings in the business cycle and associated movements in employment/unemployment levels and business investment intentions

Shifts in the relative prices of nondiscretionary goods and services, notably petrol, healthcare, education and utilities prices

Large external economic and/or financial shocks, such as the financial crisis of 2008/09 and the Eurozone sovereign debt crisis of 2010/11

Announced policy shifts in the stance of government fiscal policy, including large structural spending cuts or increases/decreases in taxation rates.

Interestingly, it is widely accepted by economists that the financial economy operating via interest rates and exchange rates acts as a buffer for the real economy in terms of external shocks, but this effect can often be magnified due to the out-sized impact on consumer and business confidence. For example, Australia was not directly affected by either the financial crisis or the subsequent Eurozone debt crisis, but on both occasions a considerable upsurge in general anxiety and slumping confidence were recorded.

Australian households and businesses reported concerns about the economy's vulnerability in the face of unprecedented upheaval in global financial markets. Not surprisingly, in some quarters concerns continue to be expressed that small open economies such as Australia and New Zealand often experience disproportionate reactions to economic and financial disturbances that emanate from much larger and more complex economies, including the US, the Eurozone, Japan, and China.

To be sure, we are not suggesting that economic policymakers should maintain inappropriate macro policy settings in order to buoy consumer and business confidence. Rather, the announcement and implementation of shifts in key macro policy needs to be sensitive to the psychological impact on households and firms in the real economy. It is the need to manage psychology that has led the major central banks to bolster their policy 'forward guidance' activities, as they fine-tune strategies to eventually end a period of extraordinary monetary policy accommodation.

It's not all in the mind as sentiment shapes activity

Although it is often said that 'confidence can turn on a dime', this should not be taken as diminishing the role of sentiment in shaping economic activity and in turn the path of business cycles. The power of confidence was patently demonstrated in late 2008 with the collapse of Lehman Brothers and the subsequent slump in global consumer and business sentiment. This was accompanied by an unprecedented collapse in global trade volumes, industrial production, investment and importantly risk-taking.

It is estimated that in the major developed economies, including Australia and New Zealand, consumer spending contributes up to two thirds of aggregate demand, based on income levels or changes, buying and spending trends, and underlying economic conditions. If we consider credit and liquidity to be the life-blood of the economic system, then it is reasonable to regard confidence as the oxygen that sustains the system.

So heightened economic anxiety and languishing confidence will have manifest impacts on the health and wellbeing of the economy, often determining whether or not it can reach and sustain its long term potential rates of growth. Recent experience indicates that there are several important consequences of low and declining levels of confidence, including:

unusually high household and business savings rates, including the hoarding of capital by financial and nonfinancial firms

subdued nominal income growth and tepid private sector credit growth

widespread household deleveraging

declining business investment spending and weak employment growth

dominance of short-term thinking and absence of longer-term strategic activity

risk of a decline in the economy’s structural growth rate and associated deterioration in productivity growth.

Therefore, economies facing 'crises of confidence' may find if this prevails it will undermine productive capacity and prove to be 'growth limiting'. In this event, it could lead to deterioration in living standards as the base of economic activity gradually contracts and the willingness and capacity to engage in risk-taking is curtailed.

Looking forward, the continuing desynchronised global business cycle and the likelihood that macroeconomic policy shifts will also vary over the next 12 months suggest that global consumer and business confidence will remain fickle. For policymakers this suggests that communication and announcement effects will continue to be crucial in managing confidence effects in economies. In contrast, investors and firms need to remain vigilant for unexpected shifts in confidence and/or the development of unsettling negative feedback loops.

For small open economies, like Australia and New Zealand, the careful management and guidance of confidence and sentiment now represents a crucial component of overall macroeconomic policy, but we suspect that finding the balance between maintaining appropriate policy settings and healthy levels of confidence remains a work in progress.

Main causes for financial deterioration are many. To begin with, improper working capital management and maintaining adequate days sales outstanding and days payable outstanding ratio which limits the free cash flows of the company and may result in having to borrow cash to run the business, which in turn will increase the company's cost of debt and the weighted average cost of capital. Financial forecasting may also have negative effects on the business if it was based on unrealistic assumptions such as assuming higher future growth rates, which makes valuation looks better than it realistically is. Last but not least, taking the time value of money and opportunity costs into account is essential when performing any financial analysis. 

The Company balance sheet should be healthy.  It can only be possible when the leverage ratio of debts to assets is strong and as well the positive equity with timely releasing the dividends.  In either case if debts exceeds the assets and negative equity responds that the company financial position is deteriorated.   As well the Income Statement status should also to be respond with upward direction of profits with revenue and a control on spending.

Low inventory turnover and receivable turnover are the main causes for deterioration of the financial situation of the company. As these ratios affect the company's ability to generate cash. So the lower receivable turnover would result in high collection period and lower inventory turnover would increase the days for sales of inventory. This would have a negative impact on company's cash flow and ultimately it would lead to financial turbulence and deterioration.

Bad credit policy management

High average collection period (future sale and repayment after one month)

High average repayment period (cash purchase and payment in advance)

The average height storage period (storage of goods for a long time and the inability to discharge aphid)

Financing fixed assets with short-term financing sources.